No need for RBA to rush into rate cut

If a week is a long time in politics, then two weeks for a central bank might just about be a lifetime.

Since the Reserve Bank of Australia met on September 4, the European Central Bank has unveiled its bond-buying bazooka, aimed at buying the bonds of troubled euro zone countries and solving the debt crisis once and for all, while the US Federal Reserve announced it would keep buying mortgage-backed bonds until their unemployment rate showed signs of improving.

Not to be outdone, China approved $US157 billion worth of infrastructure spending on rail, road and port projects, which is expected to help the world’s second-largest economy recover and provide a boost to iron ore prices later in the year.

And speaking of iron ore prices, in the two weeks since the RBA met they have also risen, by about 20 per cent, up from $US86 to $US105 a tonne.

That’s still way below the $US130 to $US140 a tonne that iron ore was fetching in the first half of this calendar year, but much higher than when the RBA met and markets were worried about the economic impact of falling iron ore prices.

China, iron ore prices, Europe and the US were all cited in the minutes of this month’s RBA board meeting that were released yesterday as well as the dollar, which the RBA said “may have been somewhat overvalued, but not substantially so".

Since then, the $A has risen to $US1.046, up from $US1.021.

Like many previous releases of RBA minutes, those from the latest board meeting talk to all the concerns investors have had for quite some time.

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And although most economists still expect the RBA to cut rates, the release shows the RBA doesn’t have to rush into it. They have time on their side.

Inflation is under control, the local economy isn’t going backwards, the unemployment rate is still quite low and business spending looks poised to remain at a record high despite a peak in the terms of trade.

In addition, given what’s happened in overseas markets over the past few weeks all seems to be calm now giving the RBA another reason to sit tight.

But Westpac chief economist
Bill Evans
argues the RBA has moved a step closer to a rate cut.

In a note to clients, he said that he still expects the RBA will begin another rate cutting cycle in November, but noted the ground work has been laid for a move as soon as October.

Traders tended to agree with this assessment, putting the chances of a cut in the official cash rate to 3.25 per cent in October at about 64 per cent, up from 45 per cent previously.

Over the next 12 months, traders still expect the cash rate will fall to at least 2.75 per cent.

Mr Evans highlighted the RBA’s current assessment of the inflation outlook. He said that it “continued to provide scope to adjust policy in response to any significant deterioration in the outlook for growth", and cited this as one reason to expect a rate cut sometime soon.

“While the word ‘significant’ literally represents a high hurdle, the fact that the discussion refers to scope to cut rates when the previous month did not mention that possibility clearly indicates that the RBA is moving towards another cut’’ he told clients.

Royal Bank of Canada maintains its forecast that the RBA will cut rates by one quarter of a percentage point before the end of 2012 with another half a percentage points of easing in 2013.

The minutes released yesterday showed the bank is worried about China. The minutes said that “the indicators for economic activity in China were a little softer overall".

The minutes also showed the RBA is worried about declines in commodity prices that are important for Australia – “iron ore and coking coal had fallen sharply of late", the minutes said.

Ironically the Bureau of Resources and Energy Economics also released its quarterly forecasts yesterday.

Iron ore contract prices are tipped to average $US101 a tonne in 2013, not far from the current spot price, but down 20 per cent from $US126 in 2012.

The coking coal price is tipped to fall 13.6 per cent in 2013 to about $US183 a tonne.

The government’s resources sector forecaster has also downgraded export income. Mining and energy receipts are expected to fall to just $189 billion in 2012-13, down from the June quarter forecast of $209 billion.

Still, for a rate cut to be made any time soon, investors need to keep an eye on retail sales and other activity data, the unemployment rate and the dollar.

Given the bounce in spot iron ore prices, the call for the RBA to cut to halt the dollar’s rise has lost some of its punch.

The slowdown in China will also be closely watched by officials. But with inflation expectations rising in the United States, rates might not be going anywhere.